Sunday, June 19, 2005

Real Estate - Is It a Top?

Three weeks -- three magazine covers. First, Fortune magazine has a cover article on America's real estate mania. The next week, TIME magazine. This week, the Economist reports on the worldwide housing boom.

Anyone familiar with the financial markets knows that popular press magazine covers are famously contrarian indicators. When something becomes so-well "known" that it warrants cover-stories in the popular press, usually the trend has reached its end.

However, the odd thing is that all three magazines struck a skeptical tone. In fact, the Economist's cover story was entirely negative, with the cover reading: "House Prices: After the Fall", and the first two sentences read: "The worldwide rise in house prices is the biggest bubble in history. Prepare for the economic pain when it pops."

Fortune and TIME both dutifully reported on the mania and excitement (e.g. people buying a condo for $425,000 and then turning and reselling it for $525,000 literally an hour later. No joke.) But both wondered if things might not be getting a bit too 'crazy', and if there might be any similarity to the Nasdaq bubble and subsequent burst.

So here's the question: if the popular magazine covers are still skeptical, then, by contrarian logic does this mean that the housing boom still has a ways to run?

One interesting fact: An increase in real estate bank loans account for about 2/3rds of the increase in overall bank credit over the last 12 months. Real estate bank loans have increased an astounding 15% year-over-year. Meanwhile, the median house price in the US has risen a record 15% over the past year. Coincidence? Well, there's no necessity for the numbers to be identical, but it makes sense that they would be somewhat proportional -- and both at record levels.

It's a classic credit boom in progress, exhibiting all the characteristics that Austrian business cycle theory describes. (See Ludwig von Mises, "Human Action" and "Theory of Money and Credit"; and Friedrich Hayek, "Prices and Production")

12 Comments:

I've been wondering the same thing. And it's also interesting that though valuation measures of the some affected groups have increased, they are not astronomical as they were for the tech stocks during the Nasdaq bubble. For example, TOL (considered by many as the best premium home builder) trades at a trailing P/E of 15 and forward P/E of 10 (see http://finance.yahoo.com/q/ks?s=TOL). Maybe higher than long term historical valuations, but hardly the stuff of a manic bubble.

Anectodally, here is more evidence. In the late 90s the high-rollers of New York City nightlife were the dot-commers: not exceptionally bright people, yet who were "instant millionaires."

Now it's real estate AGENTS that I meet who are the highrollers. I have met many not-too-bright people who are raking in cash and have nothing but contempt for buyers except multimillionaires.

One ditzy real estate agent told me that she won't even take calls from prospective buyers like lawyers and investment bankers who "only make" $200,000. They can't even qualify for a studio (i.e., one-room apartment) in Manhattan! She said if one doesn't have a net-worth of a million dollars, no co-op board will approve an application.

(Meantime, the one-bedroom apartment I rented in 1999-2000 was offered to me for $330,000. It was $275,000 the year before, so I thought it was too expensive. Now it is worth around $900,000!)

In my first comment, I was trying to make the point that often when a true bubble is in effect, people start forecasting almost infinite future profits, so they drive up valuations to insane levels. Thus if we were at the height of a bubble I would expect the valuations of home-builders (a proxy for the real estate boom) to be in the 50's to 100's, not 15. In other words, as you posit in the original post, I don't think we're yet at the height of the boom, and definitely not in "bubble" territory. That said, I think that some local markets *are* in bubble mode as Chip's comment supports as do some of the anecdotes in the articles you cite. Here is another data point suggesting a bubble in local markets: the existence of services aimed at "flipping" properties. In my opinion, one of the tell-tale signs of a bubble is the almost exclusive focus on the exchange value of a good, i.e. valuing something only by what the next buyer will (hopefully) pay. The existence of a site like this: http://www.condoflip.com/ suggests we're getting into that territory.

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Ideas cannot be fought except bymeans of better ideas. The battleconsists not of opposing, but ofexposing; not of denouncing but of disproving; not of evading,but of boldly proclaiming a full,consistent and radical alternative.
-- Ayn Rand